The loss of the protected status of special revenue bonds in bankruptcy may only be temporary if a pending appeal to the U.S. Supreme Court is successful or if more states enact protective statutes.
Both are viable options to negate the impact of
Assured Guaranty and two other bond insurers recently petitioned the Supreme Court to accept an appeal of that ruling, which involved the Puerto Rico Highways and Transportation Authority’s special revenue bonds.
The high court has not yet decided whether to accept Assured’s Sept. 20 petition. It only accepts a small fraction of the petitions it receives each year. Between 2014 and 2017 the annual petitions for certiorari ranged from 5,860 to 7,103 and their success rate ranged from 2.1% to 4.2%, according to one expert.
However, the high court has already accepted another Puerto Rico case that is set for oral arguments
The Oversight Board is overseeing the commonwealth’s debt restructuring.
Assured Guaranty’s petition also seeks Supreme Court review of Puerto Rico’s debt restructuring.
In this latter case, the issue involves a decision by federal District Court Judge Laura Taylor Swain which was upheld by the First Circuit that has had a far-reaching impact beyond the commonwealth.
Credit ratings agencies have already taken action to change their ratings criteria and have downgraded some municipal issuers because of it.
“The First Circuit’s decision has unsettled the multi-trillion-dollar revenue bond market and harmed local governments across the country, which depend on such bonds to raise money for vital public works like sewer and transportation systems,” the petition said. “The case is therefore of extraordinary importance to local governments of all kinds, and urgently warrants further review by the Supreme Court.”
James Spiotto, managing director of Chapman Strategic Advisors in Chicago, said the ruling also conflicts with protections afforded to revenue bonds in other Chapter 9 bankruptcy cases involving the cities of Detroit, Stockton, and San Bernardino as well as Jefferson County and others.
The ruling didn’t take into account the purpose of amendments made to the federal bankruptcy code in 1988, according to Vincent Marriott of Ballard Spahr in Philadelphia, whose law firm filed an amicus brief on behalf of the National Association of Municipal Analysts at the appellate court level in support of Assured Guaranty.
“What they didn’t do was take a step back and look at those provisions within the overall context of Chapter 9 and within the overall context of the revenue bond market,” Marriott said.
“Had they done so, they would have looked more carefully at the legislative history than they did and in my view, they would have seen a clear intention to amend the bankruptcy code in a way that would eliminate what had been a disruption in the revenue bond market,” he said.
Matthew Fabian, managing director of Municipal Market Analytics, agreed the First Circuit ruling has had a national impact, but he said the market impact has for the most part been minimal because only a tiny fraction of municipal issuers ever enter bankruptcy.
“It’s tantamount to finding out that your waterproof jacket is water resistant,” Fabian said. “You still want to wear it versus nothing at all. You’re still better off wearing it, but you can’t assume you’re going to stay dry.”
Fabian said the impact occurs during a bankruptcy. “The payments on special revenues during the bankruptcy are now interruptible,” he said. “And potentially the issuer could fritter that money away while the case is ongoing. It’s doesn’t necessarily mean a large loss for special revenue bondholders but it does mean some loss and that’s enough for most traditional muni investors to think twice about buying bonds held by an issuer that might file for bankruptcy.”
But Valentine said the ruling has changed the equation for investors. “The key to the revenue bond market is that it is premised on an income stream,” he said. “It is not premised on the underlying credit quality of the issuer or the municipality. And it is premised on that income stream being pledged to the bonds and being uninterrupted.”
Revenue bonds play a key role in financing infrastructure.
Spiotto said that if Congress fails to finance trillions of dollars of new infrastructure through legislation, a significant portion will need to come from bond financing. “In the next five years the bond market could very well have a $2 trillion kick to it and part of that will be by pledging revenues to a certain source for payment of the capital improvement,” Spiotto said. “And that’s special revenues. If you increase the risk in special revenues, the difference generally between a strong bond and a weak bond is about 200 basis points.”
That could translate to a 25% difference in payment of the additional interest, said Spiotto. “That’s big time. That’s money for workers, for pensions, for additional improvements, for services or a taxpayer rebate.”
Revenue bonds debt payments pay workers for operations.
Spiotto has composed a model state statute that he published in the Municipal Finance Journal that would mandate debt payments of special revenue bonds in a bankruptcy.
Some states, including California, already have laws requiring payment, Spiotto said.
“Let’s get state statutes that take it out of the hands of the bankruptcy court,” Spiotto said.
